Budget 2014: A calculated risk

Budget 2014 was the first budget to deliver less, in austerity measures, than the amount agreed with the troika. Indeed, it is a mark of how the balance of power has changed between Ireland and the troika that the government could reduce the size of the austerity package by €600m, and in reality there was very little that the troika could do about it. On the whole, this decision can be justified, but it's a close call as there was also a good case to be made to make quicker progress towards debt reduction. After all, Ireland will still borrow close to €10bn this year, adding to an already-high stock of national debt. The key issue now is whether Budget 2014 is the first step towards walking away from a sensible fiscal policy designed to get our debt under control, or simply a pragmatic recognition that the austerity package this year need not be as large as previously thought. The jury is out!

Most public and media focus on any budget is on a few controversial measures that get the headlines, but which are often very minor in terms of the overall budgetary arithmetic, or indeed in terms of what needs to be done to get the economy moving, reduce unemployment and exit the bailout arrangements. At this early stage it seems quite likely that the main debate about the Budget in the days ahead will be about very specific issues such as the abolition of the bereavement grant or the reduction in the number of elderly medical card holders. These are, it goes without saying, very important issues to those directly affected, and indeed important social issues, but it is sometimes unfortunate that the really important budgetary decisions - in broad economic terms - are almost overlooked in the entirely understandable reaction to particularly controversial measures which are minor in overall budgetary terms.

And this Budget does indeed merit serious consideration at a macroeconomic level:

It is the first Budget where the Irish government decided to essentially overrule the troika and bring in a much smaller package of austerity measures than previously agreed.

It marks the return to what economists call a "primary surplus", i.e. the budget will be in surplus when interest on the national debt is excluded.

It is the first Budget in a long time that is taking place at a time when there are genuine indications that the economy is picking up somewhat, and the approaching light at the end of the tunnel may not, in fact, be the light of an oncoming train!

If Budget 2014 was Budget 2012?

Turning to the first of those broader issues above, it is interesting to think about what might have happened if, say two years ago, the Irish government had overruled the troika and reduced the amount of austerity in the budget by 20%, as it has done this year. It seems very likely that Irish bond yields would have risen substantially, while various European policymakers would have made grave comments about the lack of commitment from Ireland to restore its finances to good order. The troika would, no doubt, have at least threatened to delay or withhold further funding, and it would have been near-impossible for Ireland to raise any money in the bond markets.

But this is late 2013, not late 2011, and the balance of power has shifted. In reality, the government no longer needs troika funding - it has access to the financial markets instead, and also has a very large reserve of cash on hand. And the international environment has changed as well, as the eurozone fiscal crisis seems to be steadily fading. So the government felt strong enough to essentially tell the troika that it didn't agree with the scale of austerity measures previously agreed. Nominally, the reduced austerity measures were "agreed" with the troika, but in practice the troika had little bargaining power.

Right Decision?

Was this the right decision? It's a very close call and there are strong arguments on both sides of the debate, but on the whole it can probably be justified. The promissory note deal reached earlier this year should result in very substantial savings in 2014 (of the order of €1bn, as an estimate), and the vastly improved sentiment towards Ireland on the international financial markets means that Irish bond yields are unlikely to react much (if at all) to the smaller than planned size of the austerity measures. At a time when the Irish economy finally appears to be turning a corner, there is a case to be made to give the economy every help possible, in fiscal terms, by reducing the size of budget cuts as much as possible.

On the other hand, of course, Ireland's national debt is very large and is still rising - we will borrow close to €10bn next year, which will in practice be permanently added to the national debt and on which interest will have to be paid for generations to come. In addition, if 'something goes wrong' in international financial markets, Ireland may once again be cut off from raising money in the bond markets and have to rely on international lenders such as the IMF and EU once again - and refusing to comply with their targets now might turn out to be costly if Ireland is forced to ask for further emergency in the future.

Taking everything into account the smaller austerity package was probably the better option. But it is very likely something that can only be done once, for many reasons. Firstly, the IMF has explicitly made it clear that it expects the shortfall from this year's budget to be made up in Budget 2015, i.e. adding the €600m of austerity measures that were not implemented in this budget to the austerity measures in the next budget. Secondly, the markets are likely to ' forgive' (if that's the right word) a budgetary shortfall in one year, based on the savings from the promissory note, but they are unlikely to be as relaxed if that happens again next year - that then becomes a trend, instead of a once-off event, and markets don't like to lend money to governments who ignore budgetary agreements and targets.

Betting on better growth

The government's hope, presumably, is that the emerging signs of recovery in the Irish economy are real, and deliver respectable economic growth in 2014 and still-stronger growth in 2015 - enough to deliver stronger-than-expected tax revenues and thus lower-than-agreed austerity measures in Budget 2015. The government may well be right - many economic indicators are lining up in the right direction. But it is a risk, without a doubt. If growth turns out to be disappointing next year and into 2015, the government is very unlikely to be able to avoid further substantial austerity measures in the next budget - and at least in theory, they could even be significantly larger than the €2bn that has been agreed already.

Jury is still out

So the government is taking a risk with this budget, privately hoping and expecting that better growth in 2014 and especially in 2015 will remove the need for extra austerity in Budget 2015. It will probably require a growth rate of the order of 3% in 2015 to achieve that aim - a growth rate that does seem very high by the standards of the last few years, but one which is achievable, with a "fair wind", by 2015, if the international environment remains favourable. The consensus forecast for 2014 is a little short of 2%, and if that is achieved 3% in 2015 is not out of the question. It will be quite some time before we know whetherteh government's calculated risk pays off or not. As we said at the outset, the jury is still out!

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